June 07, 2012

Bigger Government and Crony Capitalism

Using his home country as an example, Luiz Luigi Zingales explains better the point I was making in this post about the adverse effects on economic growth and wealth creation from growing government.

In Italy today, even emergency-room doctors gain promotions on the basis of political affiliation. Instead of being told to study, young people are urged to "carry the bag" for powerful people in the hope of winning favors. Mothers push their daughters into the arms of the rich and powerful, seeing it as the only avenue of social promotion. The nation's talent-selection process is broken: One routinely finds highly intelligent people employed in menial jobs while mediocre people often hold distinguished positions.

Once an incompetent appointee finds himself in a powerful position, he tends to hire only subordinates of equal or lower quality, since more talented people pose a threat to him. After a few years, a firm's human capital will become so eroded that it won't be able to compete without some form of protection. The more protection it can gain from government, the greater the scope of the cronyism, which in turn makes protection even more necessary. Crony capitalism creates a vicious circle.

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Seven out of the 10 richest counties in the U.S. are in the suburbs of Washington, D.C., which produces little except rules and regulations. Even worse, the slow growth and decreased social mobility of the last decade have damaged the free market's reputation as a creator of prosperity. The hundreds of millions of dollars awarded for disastrous economic performance—from Robert Rubin's salary as chairman of almost-bankrupt Citigroup to government loans for the actually bankrupt solar company Solyndra—have in turn weakened public belief in the system's fairness.

UPDATE: John Cochrane has some interesting things to say about Zingales and his work on crony capitalism.